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Effects of background risks on cautiousness with an application to a portfolio choice problem

  • Hara, Chiaki
  • Huang, James
  • Kuzmics, Christoph

We provide necessary and sufficient conditions on an individual's expected utility function under which any zero-mean idiosyncratic risk increases cautiousness (the derivative of the reciprocal of the absolute risk aversion), which is the key determinant for this individual's demand for options and portfolio insurance.

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File URL: http://www.sciencedirect.com/science/article/B6WJ3-50XCY91-5/2/9a71241483aee74a20abd1ab1299719f
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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 146 (2011)
Issue (Month): 1 (January)
Pages: 346-358

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Handle: RePEc:eee:jetheo:v:146:y:2011:i:1:p:346-358
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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  1. Kihlstrom, Richard E & Romer, David & Williams, Steve, 1981. "Risk Aversion with Random Initial Wealth," Econometrica, Econometric Society, vol. 49(4), pages 911-20, June.
  2. Hayne E. Leland., 1979. "Who Should Buy Portfolio Insurance?," Research Program in Finance Working Papers 95, University of California at Berkeley.
  3. Hara, Chiaki & Huang, James & Kuzmics, Christoph, 2007. "Representative consumer's risk aversion and efficient risk-sharing rules," Journal of Economic Theory, Elsevier, vol. 137(1), pages 652-672, November.
  4. Gollier, Christian & Pratt, John W, 1996. "Risk Vulnerability and the Tempering Effect of Background Risk," Econometrica, Econometric Society, vol. 64(5), pages 1109-23, September.
  5. Miles S. Kimball, 1991. "Precautionary Motives for Holding Assets," NBER Working Papers 3586, National Bureau of Economic Research, Inc.
  6. Franke, Gunter & Stapleton, Richard C. & Subrahmanyam, Marti G., 1998. "Who Buys and Who Sells Options: The Role of Options in an Economy with Background Risk," Journal of Economic Theory, Elsevier, vol. 82(1), pages 89-109, September.
  7. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  8. Brennan, M.J. & Solanki, R., 1981. "Optimal Portfolio Insurance," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(03), pages 279-300, September.
  9. Marti G. Subrahmanyam & G√ľnter Franke & Richard C. Stapleton, 1998. "Who Buys and Who Sells Options: The Role and Pricing of Options in an Economy with Background Risk," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-063, New York University, Leonard N. Stern School of Business-.
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